Electricity Rate Impacts on Solar Economics
In recent posts, we’ve highlighted a number of big changes affecting solar energy’s middle market. From the IRA’s impact on the ITC (growth spiral, transfers and direct pay) to NEM 3.0 in CA, and tariff cases, we’re seeing a lot of big policy shifts for the industry. But something else is changing too, which could be even more important over the long-term.
In this post, we highlight how electric rates impact customer savings, and why these changes are so significant for the middle market:
Rates are spiking all over the country, with double-digit growth not seen in many years
This makes solar energy more attractive, by increasing the savings it provides relative to electricity from the grid
Uncertainty about future electric rates elevates customer interest in solar energy’s price stability and predictability
Trends in Electricity Prices
After a decade of relatively stable electric rates characterized by modest single-digit price growth, electricity prices have shot up dramatically. Nationally the 14.1% annual increase in retail electricity prices is almost double the 7.7% general price inflation in the CPI data. And it’s not just one sector or a few regions driving this spike. According to the latest EIA data, double-digit price increases are happening all over the country:
Across all three sectors (residential, commercial, and industrial)
In 8 out of 10 regions of the country
In a majority of states (35 in residential, 30 in commercial, and 40 in industrial)
But that’s just the double digits. Electricity prices are increasing almost everywhere at much higher rates. The following chart highlights this spike for commercial customers in the context of the last 10 years.
Short-Term vs. Long-Term Price Drivers
Factors that impact electric rates are numerous and complex and vary in significance from one region to another. We’re not going to tackle this in detail. But a useful way to think about it is in two categories that align with key items on an electric bill: supply and delivery.
Utilities generate electricity or buy it from independent power producers. Big purchases of electricity happen on the wholesale market, where supply and demand vary and prices change from moment to moment.
For example, if extreme weather events cause consumers to crank up their air conditioning, electricity demand spikes and pushes up wholesale prices. Weather can impact the supply of solar and wind power, and over time even hydropower. Fluctuations in fuel prices impact other generation sources, like natural gas turbines. Sometimes we see these impacts in the form of surcharges, like the $0.06 / kWh Power Supply Cost Recovery charge currently on Consumers Energy bills in Michigan.
The other category is delivery charges, which cover the cost of electricity transmission and distribution through the grid to a customer’s property. These are typically impacted by longer term investments in grid infrastructure paid for over many years. When the grid needs major upgrades, for example to reduce the risk of wildfires or to accommodate more demand or a new source of supply, then delivery charges will go up. But they tend to increase more gradually, and without temporary surcharges.
For all rate increases, electric utilities need regulatory approval to pass additional costs on to customers. Approvals take time, and the changes are often designed to be gradual. So for many customers, recent spikes in electric rates are just the first of more price increases to come over the next few years.
Impact on Customer Savings
For the customer, solar energy is an alternative to energy from the grid. Whether the customer is a business offsetting power with a system on their roof or someone buying community solar from an array in their area, they’re inevitably comparing the price of solar to their utility rate. And the higher utility rates go, the more customers save with solar.
The chart above compares a customer’s solar PPA rate with the electric rate from their utility under two scenarios:
The utility rate (ACP, “Avoided Cost of Power”) grows at 3% and at 6% per year
The PPA rate grows at 1.5% per year, a typical escalator for a commercial solar PPA
The customer’s initial PPA rate is set at a 10% discount to ACP, with ACP starting at 10 cents per kWh and the PPA rate at 9 cents per kWh
The timeline on the x-axis is 25 years, which aligns with most solar panel warranties and many PPA term lengths
Over 25 years, the PPA’s discount grows from 10% to 37% when electric rates grow at 3% annually and from 10% to 68% (!) when electric rates grow at 6% annually.
The ACP escalators in this graph are modest compared to the spikes we’ve seen over the last year. This seems reasonable, since we don’t expect double digit price growth to continue for decades. But it does raise the question of which scenario is more likely: 3% annual increases in line with the last few decades, or 6% annual increases that might include periods like the one we’re in right now.
This kind of uncertainty is another reason that customers are attracted to the stability of a solar PPA or solar system ownership. Many see their electric bills going up and realize that they can lock in a lower rate with solar. And while initial bill savings are a great incentive for customers, and a requirement for most commercial solar PPA agreements, the biggest financial benefit may be in future years as utility rates continue to rise.
At Conductor Solar, we help developers working in solar energy’s middle market find high quality investor partners. We see a lot of financial models for solar projects, so many that we built an automated tool to price PPAs and leases. One of the biggest factors that determines whether or not a PPA project will work is the customer’s ACP. So, in addition to piquing customer interest, we expect the recent rate spike to improve the economics of solar projects and help get more commercial and community solar built across the country.
